If youre planning on buying or selling a home in any market, it is to your advantage to know the current trends. Ive heard people claim that you can tell that the housing market is softening because there are 20% more homes on the market now, compared to the same time last year. That is not necessarily true because it only looks at supply. Certainly a rise in supply could lead to a softening market. However, the fact of the matter is that, if at the same time theres 100% more buyers now, compared to the same time last year, the market is hardly softening.

Economics 101 teaches that in order to find the equilibrium to determine price and quantity, we need to know supply AND demand. Unfortunately, the amount of homes on the market now, compared to one year ago, only looks at supply. In order to truly understand what kind of market were currently in, we need to know demand. To do this, I look at months supply.

What is months supply? Basically, months supply is the ratio of inventory to sales. And what it tells us is how many months the stock of homes for sale would last, if sales continued at their current rate.

For those of us that need to see a formula:

# of homes for sale on the market
----------------------------------------- = Months Supply
# of homes sold that month

*important note - if your data for number of homes sold is for a period other than one month, remember to take a monthly average. Its months supply, not 2 months supply.

What do the numbers mean?

For some reference, in the 89 US housing market (buyers market) saw around 7 months supply. For those of us who are more familiar with more recent years, in 01 the US average was slightly below 4 months supply. But hot markets like Las Vegas, Boston, and parts of Florida and California should have seen below 2 months supply in recent years.

So anywhere around 4-5 months supply is roughly average. The further your numbers stray below that, means its more of a sellers market. The higher the number is, then the more the market favors the buyer.